Sunday, November 9, 2014

Inflation versus Interest rate




Image from Google


It has been a generally accepted fact that Bhutanese lack saving culture, they would rather invest the money elsewhere than save it in a bank. This has been a concern for the authorities and they have involved themselves into programs and initiatives like financial literacy to educate people and inculcate a savings habit in them.

Savings is important for an economy. When an individual saves his money in a bank, he makes credit available for another individual or an institution, thus one man’s savings becomes another man’s credit. Bankers can thus provide credit to another man or a government who needs ready cash for development programs. Credit is integral for development, and it saves the government from relying into borrowings from international banks where the interest rates can be relatively expensive.

So why do Bhutanese lack savings culture? Is it because we lack a proper understanding of personal finance or is it because the system in itself does not encourage people to save.

Let’s look at inflation. Inflation in Bhutan has been averaging 9 to ten percent and sat times, even 13 percent as recorded by NSB. Inflation in essence means an increase in the prices of goods and services, on the other hand it also means, decrease in the purchasing power of money.

What Nu 100 can buy five years ago, needs Nu 150 to buy today. For example, you bought a liter of vegetable oil for Nu 100 five years ago, to buy the same amount and type of vegetable oil, you are required to pay Nu 150 today.

If inflation is increasing at an average 10 percent a year, the value of your money is also decreasing at the same rate.

Now let’s look at the interest rates our banks provide for saving our money with them. Banks provide an interest rate of five percent to 8 percent over a period of one year to five years.

If you save money in a bank for one year, it will add an additional value of 5 percent to it in one year, but in the same year, the value of your money has dropped down by ten percent. Which means:

Saving- Nu 100
Interest rate- 5 percent
Inflation 10 percent
Loss- 5 percent

So, by saving in a bank, your money, rather than accumulating any value has decreased in its power to purchase. This doesn't seem to make sense. So you are technically losing money while in the process of saving. Unless the objective to save is to make money available during emergencies, there is no incentive other than that. If you saved your money in the bank for fifteen years, its value could even be halved.


And since it does not make sense to save in a bank which provide interest rate lower than inflation rate, it is important that there are better investment avenues and opportunities, which is lacking in our economy. Other than fresh IPOs (initial public offerings) made by companies, there’s no place else to invest money that provide better returns. 

So, does all this explain why Bhutanese lack a saving culture? Or as many in the authority like to believe, does Bhutanese lack an understanding of the financial system?








6 comments:

  1. Big happenings now and then ...Anyway good reflection on the issue...thanks ans keep on sharing

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    Replies
    1. thanks for being my regular reader Sancha,:-)

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  2. Exactly there is hardly any attractions to save. And on top of that, we Bhutanese spend so much on luxury goods.

    Good analysis. Keep posting.

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